AuthorAllen, Lucy P.


The global outbreak of COVID-19 and resulting lockdowns have led to record levels of unemployment and a slowdown in economic activity in the United States and around the world. The International Monetary Funds (IMF) have projected Gross domestic Product (GDP) to contract by 3% globally in 2020, which would make the current crisis the worst recession since the Great Depression.

Unsurprisingly, goodwill impairment announcements increase during economic downturns. For example, in 2008, the year of the global financial crisis, the number of goodwill impairments more than tripled compared to the 2007 level, from 463 to 1,393. Figure 1 shows the number of goodwill impairment announcements each year for all publicly traded companies in the United States from 2001 through 2019. Thus, given the COVID-19 pandemic, a substantial number of goodwill impairments is expected in 2020. In fact, in the month of May 2020 (the most recent completed month as of the writing of this paper), there were four times as many goodwill impairment announcements as in the same period in 2019 and 2018.

Before 1995, accounting rules did not specifically address the reporting of goodwill impairments. However, in the last 25 years, there have been three major changes related to regulations governing goodwill impairment accounting. First, Statement Financial Accounting Standards (SFAS) 121, effective on December 15, 1995, was the first set of accounting standards that directly addressed the impairment of long-lived assets. SFAS 121 required for the first time that companies "review long-lived assets and certain identifiable intangibles to be held and used for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable" Financial Accounting Standards Board (FASB). (SFAS) 121 further required that impairment be tested for by estimating "the future cash flows expected to result from the use of the asset and its eventual disposition" (FASB, 1995). If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment loss is recognized.

Second, on December 15, 2001, SFAS 142 became effective, requiring that companies test for goodwill impairment at least annually and more frequently in certain circumstances, and eliminating the previous requirement that goodwill be amortized over a period of less than 40 years. In addition, the impairment testing methodology was updated, requiring companies to conduct a two-step process. The first step entails comparing the fair value of a reporting unit as a whole with its carrying amount. If its fair value exceeds the carrying amount, the reporting unit is not considered impaired; otherwise, the second step is required. The second step involves estimating the fair value of the reporting unit's goodwill and comparing it to the carrying value of that goodwill. If the fair value of the goodwill is less than its carrying value, an impairment is recognized.

Third, on December 15, 2011, ASU 2011-08 became effective, relaxing the requirements of SFAS 142 and allowing companies to first assess certain "qualitative factors" to determine whether it is necessary to perform the two-step impairment test. ASU 2011-08 identifies several examples of these "qualitative factors," many of which are based on publicly available information, including a sustained decrease in the stock price, the deterioration of macroeconomic conditions, and increased competition in the industry. Although labeled "qualitative factors," these changes may have made the decision to test for goodwill impairment more objective and predictable, and thereby reduced not only the cost of performing the analysis but also the informational content of goodwill announcements.

Although there are a large number of goodwill impairments each year and substantial interest in this topic from companies, investors, and academics, there is no easy answer from a theoretical perspective as to whether goodwill impairments should have an impact on stock prices. On the one hand, a goodwill impairment is a one-time, non-cash, bookkeeping adjustment that does not directly affect a company's cash flow. On the other hand, a goodwill impairment may reveal additional information regarding a company's future prospects. This is further complicated by the fact that goodwill impairment testing is inherently subjective, raising questions about the value of goodwill impairment...

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